The Perfect Income Strategy
September 20, 2020
Dominick Paoloni, CIMA®
CIO & Founder
Portfolio Manager, IPSAX
Adjunct Professor, University of Denver
& University of Colorado
Jay Powell, the head of the federal reserve bank who controls interest rates has said many times, “We are not thinking about, thinking about raising interest rates for a long, long time”. This means that pensions, endowments, retirees, and investment managers that rely on low risk, safe income on their capital are receiving zero interest rates. According to Bankrate’s most recent national survey of banks and thrifts, the average rate for a 1-year CD is 0.28 percent. *
Most pensions have mandated in their investment policy statement that they must hold a percentage of fixed income in their portfolios for income and safety. The problem is you are holding an asset that has a zero- to negative real return after your account for inflation.
Furthermore, if interest rates on bonds are zero and the market crashes, why would investors move money into bonds driving the return even more negative? This means bonds are not going to hedge downside risk in an equity portfolio when the markets turn back down.
To find yield many investors have looked at alternative income strategies like real estate investment trust, leasing partnerships, pipelines limited partnerships, etc., which are advertising high double-digit income streams. The problem with these alternative strategies is that they are not liquid, and most importantly the strategies could default (the partnership could collapse) which would wipe out your investments completely.
Other popular alternative strategies like selling options whether it be selling covered calls or selling puts, is these strategies both are exposed to market tail risk.
Dividends are Always a Winner
Kevin O’Leary, the billionaire investor, and personality of the popular TV show “Shark Tank” has been a strong advocate of dividend stocks. O’Leary’s argument has always been to own dividend stocks to grow wealth because even if the stock drops, the companies continue to pay their dividends. Investors have bought tried and true companies in industries like utilities, big pharma, communications, etc., and if the market takes correction and the dividend stocks take a hit, just hold on and they will eventually come back.
This has been true especially since the market bottomed in 2009. The problem with that strategy is dividend stocks are still stock and stock is still exposed to market volatility.
For the pension or retiree that needs liquidity to pay their liabilities, you would hate to have to sell your dividend stocks when the markets have taken a big hit. A money market account is always the same value if you need money immediately, but it pays nothing.
Dividends Stocks with Seatbelts
What if you can own a basket of dividend stocks, which would eliminate the risk of any one company cutting their dividend and at the same own downside protection on the portfolio at no cost, that would give you a defined income without the worry of a market crash?
What this means to you is you can collect 4-6% a year in income with extraordinarily little downside risk in the underlying stocks.
Think about what I am saying. With CD’s, money markets, and bonds paying zero interest rates, where does one hold their cash? You do not want to put it all in the market, it is too risky. IPS Strategic Capital believes in adding downside insurance to a dividend portfolio, eliminating most of the market risk, 100% of default risk, 100% of interest rate risk, and it is 100% liquid. It is the perfect place to park cash.
IPS Strategic Capital designs low-cost hedging strategies that defines tomorrow’s risk today. For more information on our strategy solutions please visit our website at invests.com or call 303-697-3174.
Managing Principal and Chief Investment Officer of IPS Strategic Capital, Dominick Paoloni has served the investment community for over 35 years. Dominick received his Certified Investment Management Analyst (CIMA) through the Wharton School of Business and completed the College for Financial Planning’s CFP certification program.
Dominick is an Adjunct Professor at the University of Denver, and the University of Colorado Denver, he is a published author in a plethora of financial magazines including an academic white paper published through the Journal or Financial Consultants. Dominick frequently lectures throughout the country and internationally on the real-world use of derivatives in risk-defined money management.
Disclaimer: The information in this article should not be misconstrued as an offer, nor a solicitation, to buy or sell securities. Any past performance of any investment(s) does not necessarily indicate the future performance of any investment(s). No client, current or prospective, should assume the future performance of their investments will be profitable based on historical performance. Any backtest charts and data presented are purely hypothetical and do not represent the performance of accounts managed by IPS Strategic Capital. The results were obtained by applying a rules-based investment process to historical data. All investments have the potential for profit and the potential risk of loss. Changes in investment strategies, contributions, or withdrawals may cause the performance results of one’s portfolio to differ materially from the reported composite performance. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will either be suitable or profitable for a client’s portfolio. One should always consult an investment advisor before making any investment decisions.